Novanta Inc. (NOVT) Q4 2016 Earnings Report, Transcript and Summary

Good morning. My name is Christina, and I will be your conference operator today. At this time, I would like to welcome everyone to the Novanta Inc. 2016 Q4 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session [Operator Instructions]. Thank you. Robert Buckley, Chief Financial Officer, you may begin your conference.

Thank you. Good afternoon and welcome to Novanta’s fourth quarter 2016 earnings conference call. I’m Robert Buckley, Chief Financial Officer of Novanta. With me on today’s call is Chief Executive Officer, Matthijs Glastra. If you’ve not received a copy of our press release issued today, you may obtain it from the Investor Relations section of our Web site at www.novanta.com. Please note this call is being webcast live and will be archived on our Web site. Before we begin, we need to remind everyone of the Safe Harbor for forward-looking statements that we’ve outlined in our earnings press release issued earlier this morning, and also those in our SEC filings. We may make some comments today both in our prepared remarks and our responses to questions that may include forward-looking statements. These involve inherent assumptions with known and unknown risks and other factors that could cause our future results to differ materially from our current expectations. Any forward-looking statements made today represent our views only as of today. We disclaim any obligation to update forward-looking statements in the future even if our estimates change. So, you should not rely on any of today’s forward-looking statements as representing our views as of any date after today. During this call, we will be referring to certain non-GAAP financial measures. A reconciliation of such non-GAAP financial measures to the most directly comparable GAAP measures is available as an attachment in our earnings press release. To the extent that we use non-GAAP financial measures during this call that are not reconciled to GAAP measures in the earnings press release, we will provide reconciliations promptly on the Investor Relations section of our Web site. I’m now pleased to introduce Chief Executive Officer of Novanta, Matthijs Glastra.

Thank you, Robert. Good morning, everybody and welcome to our call. We're very pleased with our fourth quarter results, as our team continued to execute well. Our business delivered 10% reported and organic revenue growth with strong operating cash flows and profitability. Our revenue was $99 million and our operating income from continuing operations more than doubled versus last year. We beat our adjusted EBITDA guidance with an adjusted EBITDA of $19.4 million or roughly 20% of sales, which is 35% growth year-over-year. Our GAAP earnings per share were $0.22 and our adjusted earnings per share was $0.35, which was up 21% year-over-year. Operating cash flow was very strong at $13 million, up 64% versus last year. We believe that the strength of our team, our robust business model of providing proprietary mission critical functionality in diversified end-markets and our increasing exposure to the medical market is serving us well in this modest growth environment. In the quarter, we saw broad based growth momentum across the Company with high single-digit or double-digit year-over-year growth in most of our businesses. In the fourth quarter, our JADAK data collection business, the photonic segment, and our Celera Motion business, were strongest with double-digit year-over-year revenue growth. Bookings performance was solid with growth of 9.6% versus last year and a book-to-bill for the full-year of 1.05%. You will hear more details on the quarter and the outlook from Robert, but the strong fourth quarter results positioned the Company very well to execute on our 2017 guidance. Doing part of our fourth quarter results, we did closed two exciting acquisitions in the beginning of 2017. We acquired ThingMagic and increased our stake in Laser Quantum from 41% to approximately 76%. These acquisitions further are strategy to increase our presence in medical markets. Including these acquisitions, our revenue in medical markets has now increased to approximately 45% of total revenue, up from 10% a few years ago. Our partnership with Laser Quantum has been longstanding, and taking a majority stake was a natural next step in that partnership. Laser Quantum brings to Novanta a leadership position in photonic solutions in the attractive DNA sequencing and bio-photonics markets. We have reported earlier that DNA sequencing is an attractive segment within our target life science and clinical lab markets, and represents a market in which we expect to grow double-digit for the forcible future. As it kind of furthermore increases Novanta breadth and technology capabilities in photonics with a strong sub-system capability of integrated hardware and software based solutions. We see good opportunity to help expand Laser Quantum presence with existing Novanta customers. We've come to know that Laser Quantum team very well the past years and we're excited to welcome them to the Novanta family. The Laser Quantum business will be managed and reported as part of our photonic segment. We're equally excited about ThingMagic, which enhances our detection technology capabilities in the high-growth RFID market for identification and tracking with a primary focus on medical markets. This acquisition complements our existing RFID product and technology line-up and establishes a Novanta leadership position in the $200 million double-digit growth RFID market for healthcare. RFID demand in healthcare is increasing as there is an increasing need to identify, track, and connect devices, medications and patients, for optimal work-flow of patient safety. Ever since our December 2015 acquisition of SkyeTek, another RFID technology business, customer enquiries have jumped more than six-times far exceeding our internal capabilities to meet the demand. ThingMagic is joining the Novanta family at the right time and giving us the necessary engineering capability and capacity to execute on this rapidly increasing customer demand. The ThingMagic team has already moved into our Bedford facilities and the integration with the JADAK business is going well. Now, let me switch to what we’re seeing in our core markets. The medical market continue to be robust, the life sciences clinical equipment, diabetes care, and minimally invasive surgery segments, are all doing well with new design win opportunities continuing to grow. Within the life sciences market, with the Laser Quantum acquisitions, we now have a strong position at a double digit growth DNA sequencing market. We saw an improving environment in our advance industrial markets and our growth there has been helped by new products and commercial execution. Strong applications for us in the fourth quarter were marking and coding, converting, satellite communication and warehouse automation. Execution on leading indicators continue to be strong driven by increased R&D of sales and marketing investments, while reducing our G&A expenses. For the full year 2016, our design wins increased by 20% year-over-year and new product revenue increased by over 90% year-over-year. Our full year revenue from China increased by 15% versus last year, as well expanding our direct sales force in that region. In addition, the team is executing well in productivity. We delivered $7 million in productivity savings in 2016, up 40% versus the $5 million productivity savings we achieved in 2015, but just short of our goal of $8 million. Finally, I would like to point out that we delivered these results while experiencing supply constrains in our photonics and precision motions segment, resulting in a higher than desired past due situation at the end of the quarter. Now, let me turn to our operating segments. Our precision motions segment continue to be a strong growth engine with 12% year-over-year revenue growth, 23% sequential bookings growth and a book-to-bill over 1.3 and a quarter. Full year 2016 year-over-year revenue growth was 10%. Our Celera Motion business is taking advantage of structural growth dynamics driven by a well performing Apple Motion acquisition combined with favorable macro trends for precise and dynamic motion control in automation, robotics, satellite communication, and minimally invasive surgery markets. We further more see solid expansion potential as our share is relatively small the market is fragmented and attractive, and growing at a high single-digit rate. Initial modest new product revenue was booked in the fourth quarter, which we expect to be more meaningful in 2017 and 2018 as we’re increasing our investments in commercial and engineering resources in that business. Turning to our photonic segment, adjusted revenue growth in the quarter accelerated to 11% year-over-year and 7% for the full year with a full year book to bill of 1.03%. Growth in this segment was driven by an improving industrial climate and share gains from new products and global expansion. In our Synrad business line, we saw year-over-year double-digit bookings and revenue growth in medium power pull CO2 lasers, driven by new product introductions. Our Cambridge Technology beam delivery business recovered from the ERP implementation, delivered double-digit full year revenue growth, but work supply constrained in the fourth quarter around the few components and ended the year with a larger than desired past due position. Strategic growth execution in the photonic segment continues to be strong. Full year design wins in that segment were up more than 20% year-over-year, and new product revenue more than doubled year-over-year, a strong indication that our investments and innovation and commercial teams are staring to yield results. Applications that were strong were converting marking and coding, mobile phone processing and micro machining. Now, turning to our vision segment, which helps to reduce medical errors, improve workflow and patient outcomes in applications such as minimally invasive surgery, patient monitoring, life sciences and clinical lab equipment. Overall, sentiment in the medical equipment and devices market continue to improve. In the quarter, the vision segment delivered 7% year-over-year revenue growth driven JADAK. The JADAK data collection business again delivered a strong double-digit year-over-year revenue growth. Our Reach acquisition is performing ahead of our expectations in both revenue and profit contributions. For the full year, the book-to-bill in our vision segment was 1.02%. Although, we're still seeing a net adjusted revenue decline year-over-year in the NDS endoscopic business line, we continue to see sequential revenue growth in the fourth quarter in this business driven by new products launched earlier in 2016. We launched 10 new products in 2016 and we sold sequential revenue increase from these new products in the fourth quarter by 50% compared to the third quarter. In wrapping up my section, we are very pleased with our organic revenue growth and profitability performance. We saw 2016 shaping up as we expected with an accelerating top-line performance in the second half of the year. We are excited about the two acquisitions we closed in January 2017, which increase our presence in attractive medical markets. We are starting 2017 feeling confident about our outlook and our guidance of double digit reported revenue and earnings per share growth versus 2016. We continue to invest in innovation and commercial capabilities to accelerate growth and are targeting to increase our R&D spend to 9% of sales in 2017. Our 2015 and 2016 acquisitions are performing well, and our M&A pipeline continues to be very active. So, with that, I will turn the call over to Robert to provide more details on our financial performance. Robert.

Thank you, Matthijs. We delivered $99 million in revenue in the fourth quarter of 2016, an increase of 10%. The impact of foreign currency on revenue in the quarter was a negative 1%, while acquisitions and divestitures contributed roughly 12%. Organic growth was 10% year-over-year. Fourth quarter GAAP gross profit was $43 million or 43.3% of sales this compared to $37 million or 40.6% margin in the fourth quarter of 2015. On a non-GAAP basis, fourth quarter adjusted gross profit was $44 million or 44.3% of sales compared to $38 million or 42.2% in the fourth quarter of 2015. The increase in gross margins year-over-year was driven by higher revenues and improvements from our continuous improvement productivity initiative. Additionally, we also experienced growth in some of our higher margin product lines versus a year ago. This was partially offset by prior period acquisitions, which had lower growth margins than our existing businesses. Over the course of 2017, we expect to improve the gross margins of the acquired businesses to accompany average or better. R&D expenses were $8 million or 8.1% of sales versus $7 million or 8.1% of sales in the prior year. SG&A expenses were $19 million or 19.6% of sales. This compared to $19 million or 21.1% of sales in the fourth quarter of 2015. Despite the increase in sales, we kept SG&A dollars relatively flat. GAAP operating income was $11 million in the fourth quarter of 2016 compared to $4 million in the fourth quarter of 2015. Whereas non-GAAP operating income was $17 million or 16.8% of sales compared to $12 million or 13.0% of sales in the prior period. As Matthijs mentioned, adjusted EBITDA was up nearly 35% year-over-year and $19.4 million or roughly 20% of sales in the quarter versus $14.4 million in the prior year. Adjusted EBITDA for the full year 2016 was $68 million, which is at the top end of our previously issued guidance. Interest expense in the quarter was $1.1 million versus $1.2 million in the prior year, and the weighted average interest rate on our senior credit facility was 3.6%. Other income was approximately $500,000 in the fourth quarter of 2016 versus $650,000 in the prior year. Other income represents our minority interest in Laser Quantum. Going forward, as a result of the acquisition of the additional shares in Laser Quantum in January 2017, the earnings from Laser Quantum will be consolidated with Novanta's financial statements in accordance with U.S. GAAP. On the tax front, our GAAP tax rate was 35.8% in fourth quarter whereas our non-GAAP basis our tax rate was closer to 30%. For the full year, our non-GAAP tax rate was approximately 31.7% in line with the prior guidance. Our GAAP diluted earnings per share from continuing operations was $0.22 in the quarter compared to $0.18 in the fourth quarter of 2015. Our adjusted earnings per share was $0.35 in the quarter, up from $0.29 in the prior year. The increase in adjusted earnings per share year-over-year was driven by strong operating results from all three operating segments. In addition, adjusted EPS benefitted from $1.3 million from changes in foreign exchange rates in the quarter. We ended the quarter with $35 million weighted average diluted shares outstanding compared to $34.8 million weighted average diluted shares outstanding as of the fourth quarter of 2015. Turning to the balance sheet, a highlight for us in 2016 has been our strong operating cash flow which was $13.1 million for the fourth quarter and $47.8 million for the full-year 2016. This compares to $8 million of operating cash flow in the fourth quarter of 2015 and $33.4 million for the full-year of 2015. Capital expenditures were just under $1.5 million in the quarter, flat compared to the fourth quarter of last year. For the full-year 2016, capital expenditures were $8.5 million, which as previously mentioned, was dominated by investments in our ERP environment. At this stage, more than two-thirds of our business is now on a single ERP system. We completed the fourth quarter of 2016 with total debt of $81.3 million and $68.1 million of cash and cash equivalents. Our net debt as we defined in our earnings press release, as of the end of the fourth quarter was $13.1 million. Over the course of the year, we acquired 109,000 shares of Novanta common-stock under our 10b5-1 plan at an average price of $14.9. As of the fourth quarter of 2016, our 10b5 program was temporarily halted. We still have over 6 million remaining authorized shares under our share repurchase program. Finally, on December 14, 2016, the Company acquired key and electrical property around medical imaging and management technologies for approximately $4 million. Those technologies will be integrated in the Company's vision operating segment, as part of the Company's development of integrated operating room products for medical OEMs. For the full year of 2017, we expect GAAP revenue between $430 million and $435 million in comparison to $385 million in GAAP revenue in 2016. This represents roughly 12% growth year-over-year. For the first quarter of 2017, we expect GAAP revenue between $100 million and $102 million. We expect adjusted gross margins to increase 200 basis points year-over-year and R&D expenses to be around 9% of sales. Other income expense will flip from $2.2 million income benefit in 2016 through another expense as a result of consolidating Laser Quantum's results in our financial statements. For the full year, we expect our non-GAAP tax rate to be around 30%. We also expect to end the year with 35 million weighted average diluted shares outstanding. We expect 2017 full year 2016 EPS to be in range of $1.20 to $1.25 presuming no significant gain or losses from foreign exchange. This EPS guidance range compares to $1.09 in adjusted EPS in 2016. As you note, the full year 2016 adjusted EPS included $2.3 million benefit from changes in foreign exchange rates. For the first quarter, we expect adjusted EPS to be in the range of $0.22 to $0.25, presuming no significant gain or losses from foreign exchange. I will also note, excluded from our 2017 adjusted EPS guidance is $25 million to $28 million non-cash pretax gain, which we expect to recognize in the first quarter of 2017. This gain represents the excess fair-value of our previously held equity interest in Laser Quantum over our prior carrying value. As a reminder, the financial statements for Laser Quantum will now be consolidated in the Company's consolidated financial statements starting in the first quarter of 2017. Finally, adjusted EBITDA is expected to be in the range of $80 million to $82 million for 2016, up approximately 20% year-over-year. For the first quarter of 2017, adjusted EBITDA is expected to be between $16.5 million and $17.5 million. Our financial outlook and guidance is consistent with the full-year outlook presented in early January. Subsequent to closing out 2016, we have signed and closed on two acquisitions Laser Quantum and ThingMagic, which we discussed before. Absent any further acquisitions, we expect to have net debt of $45 million by the end of the first quarter of 2017. We have a fairly robust acquisition pipeline. Our growth opportunities continue to look pretty exciting. And our productivity engine is making great progress. We are proud to close out 2016 strong but more importantly we expect 2017 to be another large step in achieving our 2020 strategic vision. This concludes our prepared remarks. We’ll now open the call up for questions.

[Operator Instruction] Your first question comes from Lee Jagoda from CJS Securities. Your line is open.

So starting with Laser Quantum, can you talk a little more about the current customer mix, the current mix of end markets? And why you believed it was time now to take your equity interest up given what's going on in the cycle et cetera?

So as we reported, Lee, Laser Quantum has a very strong position in the DNA sequencing market, that’s a pretty consolidated customer market. But they also have an increasing presence in other bio photonics market. And we feel that with the Novanta sales forces, we can actually help them to diversify into those of our customers where actually Novanta has a strong presence. And the combination of their technology and our market strength we feel is a very good combination.

And then just looking at the financials, how should we think about both gross margins at Laser Quantum versus your core, and things like tax rate given their UK presence?

Yes. Their gross margins are higher than the gross margins of Novanta's average, that’s a benefit for us I won’t go in the specifics there. But that’s certainly a benefit, that’s not been the case in some of our prior acquisitions where we had to drive cost reductions and get additional leverage. So, it's nice to have something that’s got gross margin above where we currently report. It's got a much lower tax rate. I think the statutory rate in the UK is somewhere around 17%, and will continue to drop. And so from that perspective, it should generate some nice cash flows as well.

Then switching gears a little bit on ThingMagic. It appears to be a pretty good fit given some of the IP you previously acquired. Are there other areas where you think that you can make acquisitions where you have a similar dynamic, meaning your own one piece of the puzzle and there is another piece to go out? And if so where are those areas you’re looking?

Yes, we got multiple, Lee. It's hard of be super specific there of course, but one area that we commented on is in the precision motion space where it's a fragmented market and there is multiple pieces to the puzzle to come up with a total solution. And we have quite a few pieces of the puzzle, but we’d like to further add and we cannot do that organically or inorganically. So, we expect those to be active and continue to report in that area.

And then Robert, one last one for you, and assuming no additional changes in the U.S. tax code, which is always a fun assumption. You’ve made some really good progress on your non-GAAP tax rate in '17. What's the thought for that one over the next several years?

Yes, as we look at 2017, we’ll drive it down to something around 30%. I think there is additional opportunity there, even absent any changes in the U.S. tax structure. It does -- some of the rhetoric that’s been coming out in that area does give us a little pause, because I think we’re pretty well positioned from that regard. 60% of our revenue is shift outside of the U.S., the majority of our manufacturing is still done within the U.S. And so, we enjoyed a higher tax rate as a consequence of that. To the degree that changes, I think there is a big opportunity for us there. We just have to see how that unfolds in to what's in the details around that. But regardless of that, driving -- absent any changes in the U.S., I think the 30% next year and that continuing to drop maybe another hundred basis points the year after is something that we feel we can achieve with this structure

And I don't know if I missed it or we didn't have it yet. But did you give CapEx guidance for 2017?

We did not. I don't think it's going to be materially different than where we’ve finished off this year. We have some additional ERP investments that we need to make to finish off the implementation through the other one-third of the business. So, somewhere in the range of what we reported this year is probably fine.

Your next question comes from Jared Berlin from Thames Capital Management. Your line is open.

It seems like M&A going to be an increasingly important part of the strategy going forward for the next several years. And I was wondering if you could just detail for me the criteria around which or the framework around which you think about M&A from the perspective of financials with the ROI you're looking for over what period of time. And then how should we think about the rate fundamental fit for these acquisitions? Thank you.

Let me start with commenting on just the strategic part, and then Robert will comment on the financial criteria part. Our business model is really around proprietary mission critical functionality to OEM equipment makers in advanced industrial and medical markets. And we've been very active with our acquisitions to increase our medical presence. So, that's kind of a strategic framework. So we really, when we acquire companies, we want that business model fit and that market fit to be there. And then if you look from a grid of technology and markets, we either want to further enhance our technology position in existing markets like what we have done in let's say the RFID acquisition we've recently done, or actually further enhance our technology positions in target end markets, increasing dollar content in target end markets like minimally invasive surgery, life sciences and so on. And that could extend to additional product categories, provided that we see good cross-selling opportunities with our existing medical customer base. So that's how you need to look at it strategically. When we went out last year and provided the vision to double the Company, so we were up at roughly $375 million at that time, so doubling to $750 million. We said that about one-third would be through organic growth, which is 5% to 7% organic growth and number, which with the recent organic growth performance that we have we're comfortable in hitting. And then the other two-thirds with acquisitions and the two recent acquisitions are already a good step in the right direction there. So, that's kind of the -- there's a strategic framework the way we think about. And Robert can further comment on the financial criteria that are very important to us.

So, from a financial perspective, we generally focus on cash returns. So we look at cash on cash returns that have to accretive to our own returns. We look at return on invested capital. We have a minimum requirement of 10% by year two for any bolt-on and then larger platforms we’ll look on a case-by-case basis. And we also look for some revenue growth accretion to our existing portfolio. So we don't focus a whole lot on just pure earnings accretion, but that's largely because everything nowadays is only accretive given the cost of debt is nearly zero.

[Operator Instructions] Your next question comes from Christopher Hillary from Roubaix Capital. Your line is open.

I wanted to ask in both your industrial medical end-markets, you note robotics and automation as one of the applications. Can you share with us how large that is of the segments and then perhaps are those areas that are growing faster than the overall portfolio?

We haven’t split out and we're not going to do that in this call with those numbers. But I can tell you that those opportunities are growing at high single-digit or double-digit for us. We are leader in providing precision motion solutions for robotic surgery. And I'm sure you can read-up on that market, which we feel was attractive long-term. Also, laboratory automation, basically increasing throughput and precision of lab equipment requires precision motion, and we’re well positioned there. And on the industrial side, I think there is a lot of news around automation and robotics. We have a niche position there. But applications like autonomous vehicles or warehouse automation are good applications for us that are relatively small but are fast growing. So, that's how you need to see. We think that long-term overtime those will become more dominant applications for us, and the growth from a relatively small base and we're going to add to it organically and inorganically.

And then if I may add one other question, which is we've seen a lot of strength in these manufacturing surveys so called from the soft data. I wanted to ask if you are seeing any change in the cadence of business in your industrial end-markets given there seems to be an usually high amount of optimism reflected in these surveys currently?

We’re reading the same surveys of course I mean, while we look at them. But primarily we're looking and discussing with our direct customers and looking across different applications what's happening. As we reported in the fourth quarter we saw an improved advance industrial market momentum, so we're seeing that as well. And we feel good about 2017 from that remark from that perspective. Now, having said that, we're not going to be dependent on market alone, we're increasing share by introducing new products and by expanding our sales forces. So no matter what the cycle, we feel will do better. And we’re well positioned and we’re introducing new products and expanding in new markets and regions, so that's how you need to look at us quite frankly.

There are no further questions, at this time. I turn the call back over to Matthijs Glastra for closing remarks.

Thank you, Operator. So, to summarize, I would say we're very proud of our accomplishments in 2016 and how we finished off the year. We successfully rebranded the Company. We seamlessly transitioned our Company's leadership. And our focus on accelerating profitable growth was evident in our strong financial results. The diversity and strength of our businesses have served as well in this modest growth environment. We feel that our strategic direction with an increasing exposure from medical markets positions us well. As discussed before, we're now entering the growth phase in our transformation journey focused on multiple growth drivers. We have leading positions in growth markets. We’re expanding our served markets through innovation in M&A with focus on expanding our medical presence. We are achieving deeper market penetration globally through a stronger and larger sales force. All of this while maintaining our commitment to disciplined execution and our continuous improvement businesses. We appreciate your interest in the Company and your participation in today's call. I look forward to joining all of you in a few months on our first quarter earnings call. Thank you very much and this call is now adjourned.

This concludes today's conference call. You may now disconnect.